CAC payback is a metric used in SaaS and eCommerce to determine how long it will take to recoup the costs of customer acquisition. Having an understanding of the CAC payback is critical for SaaS and e-commerce companies to structure a proper distribution, sales, and marketingstrategy.
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Understanding CAC payback
CAC (customer acquisition cost) payback describes the number of months that are required to recoup the money invested in acquiring new customers.
This metric is otherwise known as the breakeven point and clarifies how much capital the company needs to grow.
The shorter the payback period, the more quickly the company will become profitable.
CAC payback is a critical go-to-market metric for SaaS companies, with the most successful making it a board-level target.
To that end, continuous negotiation ensures the payback period is both predictable and reliable.
Calculating the CAC payback period
There are no formal or standardized means of calculating the CAC payback period.
One possible method, however, relies on the following three metrics:
Customer acquisition cost (CAC).
Average revenue per account (ARPA), and
Gross margin percent.
To calculate the CAC payback period in months, divide the CAC by the ARPA multiplied by gross margin percent.
Higher numbers indicate the company is overspending on customer acquisition. Lower numbers indicate the reverse.
Many consider a payback period of 12 months to be ideal, but a wiser strategy is to consider competitor benchmarks in conjunction with two additional metrics:
Logo retention
The percentage of customers a business retains over a period of time.
For SaaS companies, this is expressed as a percentage of customers who renewed their accounts out of all those due for renewal over the same period.
Net dollar retention (NDR)
A measure of how much monthly or annual recurring revenue has increased or decreased over time.
NDR also considers factors like downgrades and negative churn.
CAC payback and lifetime value
To determine how much should be spent on customer acquisition, businesses should calculate the CAC payback to lifetime value (LTV) ratio.
Lifetime value is the amount of revenue that, on average, a customer is expected to generate over their relationship with a company.
To calculate LTV, subtract the direct expenses per customer from the revenue per customer and then divide this number by one minus the customer retention rate.
To calculate CAC, divide the number of acquired customers by the direct marketing spend.
Calculating the CAC
LTV ratio is then a simple matter of dividing CAC by LTV.
CAC Payback case study
Consider an eCommerce shoe company that spends $5,000 on an AdWords campaign and in the process, acquires 500 new customers.
Average revenue per user is determined to be $45, while the cost of fulfilling each shoe order is $20.
Lastly, the shoe company retains 60% of its customers each year.
From this, we can see that the customer contribution margin is $45 – $20 = $25.
LTV equals $25 divided by (1-60%) = $62.50.
CAC equals $5,000 divided by 500 = $10.
Thus, the LTV/CAC ratio is 62.5 divided by 10 which equals 6.25x.
In this example, the ratio is reasonably high which means the shoe company is acquiring customers profitably.
Key takeaways
CAC payback is a metric used in SaaS and eCommerce that determines how long it will take to recoup the costs of customer acquisition.
A payback period of 12 months is considered to be ideal, but a wiser strategy is to consider competitor benchmarks in conjunction with metrics such as logo (customer) retention and net dollar retention.
To determine how much should be spent on customer acquisition, businesses should calculate the CAC payback to lifetime value (LTV) ratio.
Key Highlights
Definition and Importance: CAC Payback is a crucial metric in SaaS (Software as a Service) and e-commerce sectors. It calculates the time it takes for a company to recover the costs invested in acquiring new customers. Understanding this metric is vital for shaping effective distribution, sales, and marketing strategies.
Significance of Payback Period: The CAC Payback period represents the number of months needed to recoup customer acquisition costs. It’s also referred to as the breakeven point, shedding light on the capital required for growth. A shorter payback period indicates quicker profitability.
SaaS Emphasis: CAC Payback is especially significant for SaaS companies, with successful ones often setting it as a target at the board level. Continuous assessment and optimization ensure a predictable and reliable payback period.
Calculation Approach: While there’s no standardized method, one common way involves three metrics: Customer Acquisition Cost (CAC), Average Revenue per Account (ARPA), and Gross Margin Percent.
Calculation Formula: To calculate the CAC Payback period in months, divide CAC by (ARPA × Gross Margin Percent). Higher numbers indicate overspending on acquisition, while lower ones suggest efficiency.
Additional Metrics: To refine assessment, consider competitor benchmarks along with two more metrics:
Logo Retention: Percentage of customers retained over a specific period.
Net Dollar Retention (NDR): Measures changes in recurring revenue over time, considering factors like downgrades and negative churn.
LTV Ratio and CAC Payback: The CAC Payback to Lifetime Value (LTV) ratio is crucial. LTV is the expected revenue from a customer’s entire relationship with the company. Calculate LTV by subtracting direct expenses from revenue per customer, then dividing by (1 – customer retention rate). Divide the acquired customers by direct marketing spend to calculate CAC. The LTV/CAC ratio determines acquisition spending.
Case Study: For instance, an e-commerce shoe company spending $5,000 on an AdWords campaign acquires 500 customers. Average revenue per user is $45, with a cost of fulfilling each order at $20. Retention rate is 60%. LTV is $62.50, CAC is $10, and the LTV/CAC ratio is 6.25x. This high ratio indicates profitable customer acquisition.
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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
